Heed the Warning Signs of Lower Spending Patterns
As the ex-member states of the Soviet Union will soon find out, one of the wonders of capitalism is how consumers ultimately dictate the prices of goods and services.
From an investor’s point of view, however, the wonder often ceases when a company whose stock you own is suddenly forced to cut product prices to stay competitive. Nowadays, price-clipping is happening all around--and it’s raising painful questions for stockholders, who have to wonder if the first sign of falling prices is always a warning of much worse to come.
The weak economy has sparked one price war after another this year, as companies scramble to try to put financially strapped consumers back into a spending mood. Fast-food chains were among the first to succumb, offering new low-priced “value” items to boost flagging traffic.
Since then, we’ve had gasoline wars, air fare wars and amusement park wars (Disney, among others, slashed ticket prices). Even in August, when the economy was supposed to be coming out of recession, the retail sales results announced Thursday showed that consumers by and large only wanted to shop where they knew they’d get things cheaper--Wal-Mart, Pic ‘N’ Save and Clothestime, for example.
Of course, this isn’t the first time in history that some prices have come down because of a recession. The question is whether this wave of price-cutting reflects deeper troubles within the economy.
This is every corporate marketing executive’s nightmare: What if American consumers really are so spent-out, over-indebted and under-saved that it’s going to take us all years, collectively, to repair the financial damage? How will companies raise prices to cover costs in such an environment--or worse, how will they avoid being forced to cut prices further, pulling profits and their stock prices down in tandem?
For Boston-based money manager Scott Black at Delphi Capital, it was time to unload McDonald’s when the fast-food king cut prices earlier this year in a painful bid to revive customer loyalty.
“They told us in Harvard Business School, if you’re the leader in the business, with a branded image, you never compete on price, you never start a price war,” Black says.
Those worries clearly are dogging food companies such as Borden and Pepsico this week. The stocks were hit hard Thursday on concerns about a new round of price-cutting in the highly competitive snack-food business. Borden tumbled $2.125 to $33.625, and Pepsico, which owns Frito-Lay, lost $1.25 to $29.875.
Throughout most of the 1980s, food companies enjoyed the best of both worlds: They were able to raise product prices consistently as Americans’ consumption mentality went into hyperdrive, while at the same time the cost of raw materials (grain, meat, etc.) was falling. Naturally, profit margins ballooned.
But ask Smith Barney, Harris Upham & Co. analyst Ronald Morrow about food companies’ pricing power today, and he answers simply, “There is none.” Demand is down as consumers cut back, yet transportation and packaging costs are up. Promotional costs are skyrocketing too, as producers fight for supermarket space. “It’s costing a lot more to put products on the shelf,” he says. Even a continuing decline in commodity prices isn’t enough to compensate.
The result for the most troubled food companies is at best a flat profit outlook. Borden announced Wednesday that its 1991 earnings per share will perhaps reach $2.35 to $2.40, down from $2.46 in 1990. Last week, Coca-Cola Enterprises, the largest Coke bottling company (it’s 49%-owned by Coca-Cola Co.), said it would be forced to cut prices in coming months because of steep competition in the soft-drink business. The company indicated that it might barely stay in the black in the second half of this year.
Can’t price-cutting be a good thing in the long run, if it means a company will expand its market share? In theory, that can be true. Price-cutting is always rampant in the computer business, for example, as new competitors produce better machines at lower cost and widen the audience. Irvine-based personal computer maker AST Research plays that game as well as anyone.
But when it comes to food and beverage companies, Disney, retailers and other businesses that lived high off the consumer for most of the ‘80s, there is a nagging fear that many of these firms don’t yet understand how different a world this will be in the ‘90s--and how broadly their notions about pricing will have to change in a slow-growth, low-consumption economy.
No doubt many of these companies will survive the changes. The question is at what short-term cost to profits, and to their stocks, which generally continue to hang at high levels despite growing concerns about price competition. Investors must realize that these trends are never apparent overnight--they take time to unfold, and so does Wall Street’s reaction.
The Commodity Research Bureau futures index, which gauges the price trend of a basket of 21 basic commodities, has fallen to its lowest level since early in 1987.